Second Mortgage, first headache?

By Jack, on August 20th, 2008

It seems so easy. Need to get some money out of your house? Make repairs? Buy a new car? Leave your first mortgage in place and simply sign up for a second mortgage. Nothing to it, right? Before you make that commitment think about some of the problems with a second mortgage.

These mortgage come with many names. “Home Equity Loans” is a common one. “Line of Credit” is another. Some allow you take money out as you need it. Others give you all the money up front and bill you monthly for payments.

First, what is it? A second mortgage is simply another loan, secured by your house that, legally speaking, comes “behind” your first mortgage. That means if your house is foreclosed and sold, the second mortgage holder won’t be paid until after the first mortgage holder. If the house sold for less than the amount of the first mortgage, than the second mortgage holder gets nothing at all.

Because the mortgage is “second” to the primary (“first”) mortgage, the lender is taking on greater risk, and the interest rate is going to be higher. Often it is much higher. You should always compare how much you would be paying in interest if you rewrote your first mortgage for a higher amount to cover what you need rather than adding a second mortgage. It might be more work to do a first mortgage, but it may be worth it, unless you have a really low interest rate on your first mortgage.

How do the numbers on a first mortgage re-finance vs. getting a second mortgage compare? For example, if your first mortgage is $100,000 at 6% and you are thinking about a second mortgage at 8% for $25,000, this would give you an average interest of 6.25%. You could save some money (more than $300 year) if you rewrote your first mortgage for $125,000 at 6%.

There are other reasons for not using a second mortgage. One is that if you ever run into trouble and want to reduce your principle to prevent foreclosure, the holder of the second mortgage — who is likely to lose everything if the principle gets reduced — has no incentive to go along, even if the holder of the first mortgage is willing.

And one more item: It is easier, I think, to underestimate the burden of two mortgage payments than one big one. So, you are more likely to take on more mortgage than you can afford if you do a second mortgage on top of your current one. And if things go wrong, your house is at stake.

On the positive side, a second mortgage can be a better way to get a lower interest for a car purchase, IF you can afford to pay it down quickly, and if you are pretty sure you can make the payments so your house is not at risk. You should compare car loan rates to second mortgage rates and payment plans.